Can A Company Follow Mercantile And Cash System of Accounting At The Same Time ?

 

An assessee is free to adopt an accounting method -mercantile or cash – or even a method of accounting which is regularly employed by it . The basic thing is that the accounting system adopted should be fair and should be followed regularly. This is what section 145 of the I T Act provides.However,under Companies Act  there is only one kind of accounting system allowed i’e mercantile accounting system. Section 209(3)(b ) of the Companies Act   provides that a company must maintain the accounts on accrual basis .

The questions ,therefore , are

1.  Can a company  follow the cash system of accounting for the purpose of Income Tax Act even though it is following mercantile under Companies Act .In other words , whether section 209 of the I T Act overrides Income Tax Act as far as accounting method is concerned?
2. Whether a company , which was following hybrid accounting system for quite longer time , are required to change its accounting system either in cash or mercantile for the purpose of Income Tax Act?

The author finds the answer for both the aforesaid question is NO as per higher judiciary fora.

[viral-lock message="For Reading More , Please  login by clicking either facebook or G + or Twitter "]

Two recent judgments of higher appellate authorities ( as detailed below)  have come on the same issue –

1. Delhi High Court in Cyber Media (India) Ltd vs CIT [ 2011] 338 ITR 177 and
2. Mumbai Tribunal decision DCIT vs Stup Consultants (P) Ltd. No. 5617/Mum/2009, ITA No. 6062/Mum/2009, ITA No. 6063/Mum/2009

Analysis of the Mumbai Tribunal decision on accounting method

The facts involved in DCIT vs Stup Consultants (P) Ltd was that the Assessee , a private limited company, was earning income from professional services/consultancy services in the field of civil/structural engineering and architecture by providing design, supervision and project management. For AY 04-05, the Assessee filed return of income declaring total income at Rs.4,76,57,440/-The total income was computed on the cash system of accounting .The P & L account of the assessee under Companies Act was however was based on mercantile system of accounting was showing Rs.7,48,91,325/-. as net profit.

The A.O did not accept the two different methods application by assessee and by relying on the decision of Delhi Tribunal in case of Amarpali Mercantile (Private) Ltd. vs. ACIT 45 ITD 386 (Del) held that the corporate assessee can not show income as per cash system when it has to follow the mercantile system as per section 209 of the Companies Act.

The CIT(A) deleted the addition made by A.O rejecting A.O’s action of not accepting the action of assessee to show income as per cash system .

The department appealed to Tribunal which held in favour of assessee on following grounds

1. Section 145 of the I T Act does not bar a corporate assessee from mainting accounts either on cash or mercantile basis.
2. Section 209 of the Companies Act does not override Section 145 of the I T Act. For this , it accepted the decision given by Hyderabad Tribunal in of Chennai Finance Co. Ltd. 81 ITD 7 (Hyd.) that section 209 of the Companies Act does not override section 145 of the Income Tax Act.
3. Rule of consistency applies to the assessee’s case as the assessee was maintaining books of accounts on cash basis for quite a number of years and inf fact in earlier years , such system of accounting was accepted by the A.O in scrutiny assessment.
4. The facts of the case of Amrapali Mercntile was different as in that case  method of accounting regularly employed by the assessee for the purpose of its business was mercantile system of accounting whereas only for income tax purposes, accounts had been drawn up as per cash system of accounting.
On the contrary , in the instant case , the assessee regularly employing cash system of accounting for the purpose of its day to day business activities and only that was followed for computation of Total Income under Income Tax Act. If a deviation was made , it was for Companies Act for abiding by the provision u/s 209 of the Companies Act.

Analysis of Delhi High Court on Hybrid accounting method

The facts of the case was that the assessee filed its return declaring total loss of Rs 3,94,421   on 31.12.1989 . However it paid tax u/s 115J of the I T Act on deemed income of Rs.64,610/- . In the return, in respect of the said deduction, the assessee had appended the following note:-
“To comply with the amendments in the Companies Act, 1956 which made it mandatory for the company to maintain the books of accounts on accrual basis Rs.5,85,428/- was shown as advertisements income accrued and due  and since, the method accepted by the Company is Hybrid system of accounting, i.e., where income has been accounted for on cash basis, the same being yet to receive is hereby deducted.”
The A.O did not agree with the contention of assessee and disallowed such deduction of advertisement income which assessee did not take as income for the purpose of computing total income under Income Tax Act on the ground that it follows the cash accounting system .
Both CIT(A) and ITAT sustained action of A.O.

The ITAT decided in favour of revenue stating that the change of accounting system from hybrid to mercantile system should have been followed also in case of Income Tax Act .

On appeal to High Court, The Court overruled the decision f Tribunal in favor of assessee stating that

(i) the assessee had been following hybrid system of accounting till the preceding assessment year i.e., Assessment Year 1988-1989;

 (ii). the assessee had been accounting for income received from advertisement on cash basis, which admittedly had been accepted by the revenue in the preceding years ending with Assessment Year 1988-1989; and

10. Similarly, with regard to the issue as to whether the change in the method of accounting from ‘hybrid’ to ‘mercantile’ system was “bonafide”, the Tribunal observed as follows:-

The  change in the system of accounting from a ‘hybrid’ to a ‘mercantile’ system was carried out by the assessee for bonafide reasons on account of the amendment carried out in the Companies Act.

Once, it is not in dispute that  the assessee had regularly employed a hybrid system of accounting for income tax purposes and it was only to adhere to procedure under the Companies Act that it switched bonafidely to a mercantile system – it was error on part of Tribunal to hold that  the assessee’s income for the purposes of income tax proceedings could not hark back to the hybrid system.

Conclusion on adoption of accounting method

Respectfully following  aforesaid reasoning of Delhi High Court and Mumbai Tribunal , conclusion  on the issue of accounting method  as under

• Section 209 Companies Act does not   over ride section 145 of the I T Act.
• Income Tax Act has provided the clear and unambiguous provision regarding method of accounting.
• In case of method of accounting, nowhere, it has been mentioned that an assessee cannot follow a different accounting method than Companies Act. This is important because wherever law makers wanted to say for adjustment of accounts under a different law   , it has stated so. For example, under MAT, book   profit has to be computed by making certain specified adjustments to net profit as per P & L account prepared under Companies Act. Another example is depreciation, which is different for I T Act and Companies Act and it is specifically provided that under I T Act , depreciation as per I T Act rules will be allowed.
• If an assessee followed cash accounting system or even hybrid accounting system regularly , then it is perfectly alright , even though , for compliance of section 209 of Companies Act it prepares it P & L account on mercantile system only.
• One of the conditions which must be fulfilled is that even books of accounts should be maintained in the method of accounting which assessee has followed regularly.